Supply chain strategies: Which one hits the mark?

Supply chain strategies generally conform to one of six types. Choose the best one for your organization, and you'll manage your business more effectively.

Supply chains encompass the end-to-end flow of information, products, and money. For that reason, the way they are managed strongly affects an organization's competitiveness in such areas as product cost, working capital requirements, speed to market, and service perception, among others. In this context, the proper alignment of the supply chain with business strategy is essential to ensure a high level of business performance.

In 1997 Marshall Fisher introduced the revolutionary concept of supply chain segmentation in his famous article "What is the right supply chain for your product?"1 Following Fisher's article, several academics and consultants, including Lee,2 Gattorna and Christopher,3 Ketchen and Hult,4 Martí­nez-Olvera and Shunk,5 and the consulting firm A.T. Kearney,6 among others, developed several models regarding the formulation of supply chain strategy.

Despite these advances in supply chain theory, traditional approaches to formulating and validating supply chain strategy have not been consistently successful. This is largely because they have not paid enough attention to the connections and combinations among key drivers throughout the value chain, nor to their alignment with an industry's competitive framework and with each organization's unique value proposal (also called the "value proposition").

In order to address this shortcoming, I have conducted an analysis of the most widely recognized theories and case studies about supply chain strategy. My analysis has identified a set of common patterns that reveal key drivers of supply chain strategy and explain how these can be aligned in a coherent strategy. Those findings are summarized in a strategy-formulation model called the "Supply Chain Roadmap," which provides:

a compilation of the most relevant key drivers of a supply chain strategy;

an understanding of the interrelation of these key drivers with an industry's competitive framework and a business's competitive positioning; and

This article will describe each supply chain type and will outline the criteria for adopting them, thereby helping to answer one of the most frequently recurring questions among supply chain executives: Which supply chain strategy best fits my business?

The four elements of supply chain strategy
To paraphrase Michael Porter,7 while operational efficacy deals with achieving excellence in individual activities or functions, supply chain strategy defines the connection and combination of activities and functions throughout the value chain, in order to fulfill the business value proposal to customers in a marketplace.

Accordingly, an organization's supply chain strategy is shaped by the interrelation among four main elements, as shown in Figure 1: the industry framework (the marketplace); the organization's unique value proposal (its competitive positioning); its internal processes (supply chain processes); and its managerial focus (the linkage among supply chain processes and business strategy). Although each of these elements includes multiple factors, only some of those factors are relevant drivers for the formulation of a supply chain strategy.

Industry framework. "Industry framework" refers to the interaction of suppliers, customers, technological developments, and economic factors that affect competition in any industrial sector. Within this framework are four main drivers affecting supply chain design, all of them interrelated:

Demand variation, or demand profile, influences the stability and consistency of the manufacturing assets' workload, and consequently is a main driver of production efficiency and product cost.

Market mediation costs. Market mediation costs, as defined by Marshall Fisher, are costs associated with the imbalance of demand and supply. Examples include product price markdowns to compensate for excess supply, and lost sales when demand exceeds supply. These costs, which reflect the unstable and fragile balance between lost sales and product obsolescence, arise from the consequences of the degree of demand predictability.

Product lifecycle, which is continually getting shorter in response to the speed of change in technology, fashion, and consumer product trends, affects the predictability of demand and market mediation costs. Consequently, it pushes companies to increase the speed of product development and to continuously renew their product portfolios.

Relevance of the cost of assets to total cost becomes critical in industrial sectors where business profits are highly correlated with the asset-utilization rate. Companies fitting this profile must assure high utilization rates, often to the detriment of working capital and service levels. In industries where the relevance of the cost of assets is low, companies may choose strategies that focus on responsiveness. In these cases, the asset-utilization rate falls between high and low, but responsiveness to unexpected demand is high, increasing customer satisfaction and reducing market mediation cost.

Unique value proposal. The second element, the unique value proposal, requires a clear understanding of the organization's competitive positioning in terms of its supply chain. A good approach to this is the concept of "order qualifiers" and "order winners" described in 1995 by Alex and Terry Hill.8 These concepts define, respectively, the minimum requirements for being considered as a relevant option by customers, and the performance aspects that best differentiate the company from its competitors and therefore help to win customer orders.

Recognizing the main "order winners" (in terms of product features and service) in a company's value proposal allows the enterprise to shape the connection and combination of the key drivers that must be incorporated into supply chain processes in order to ensure the fulfillment of that value promise to customers.

Managerial focus. Before discussing the fourth element—internal processes—it is important to explain the linkage and alignment between an organization's competitive positioning and its supply chain processes. The connection between these two areas is governed by the decision-making process and is driven by the supply chain's managerial focus.

This focus is the most important factor in ensuring coherence between supply chain execution and a business's unique value proposal. Yet it also can be an area where organizations are more likely to fail. Such failures mainly result from a standard managerial approach that emphasizes efficiency-oriented performance indicators regardless of the competitive positioning defined by the organization. This approach encourages companies to focus on seeking local efficiencies that may conflict with their value proposal to customers, thus creating misalignment between the supply chain and business strategy.

Internal processes. The fourth element, internal processes, provides an orientation that ensures a proper connection and combination within the supply chain activities that fall under the categories of source, make, and deliver. (See Figure 2.) Among the many factors encompassed by this element, the most important are asset utilization and the location of the decoupling point. The decoupling point is the process in the value chain where a product takes on unique characteristics or specifications for a specific customer or group of customers. There is a high degree of interdependence between these two factors, and they in turn govern other factors:

When the business framework is characterized by a high degree of relevance of the cost of assets to the total cost, and/or when the unique value proposal is oriented to low cost, the high utilization of assets is mandated. Consequently, the location of the decoupling point should be at the end of the transformation process, or at least at the output point for the most relevant manufacturing asset in terms of cost.

Prior to the decoupling point, processes are "push," therefore the workload leveling is smoothed by the forecast, the production cycle tends to be long in order to increase production efficiency, and the asset-utilization rate is high.

After the decoupling point, processes are "pull," therefore asset utilization hovers around the medium level, the workload is driven by demand and is therefore highly variable, and the production cycle tends to be shorter in order to reduce the order cycle time and increase customers' positive perception of service.

The largest portion of the inventory, which is partially manufactured and ready to configure according to customers' requirements, is concentrated just before the decoupling point.

When the decoupling point is located farthest from the customer's end of the supply chain, product customization increases, therefore demand buffering should be supported by excess capacity. In addition, collaborative relationships with customers become more useful because they help to reduce demand uncertainty.

When the decoupling point is located toward the customer's end, product customization diminishes. Consequently, the minimum size of the order does not depend on the size of the manufacturing batch, and minimum order size is governed by the relevance of transportation cost to the total cost.

Six generic supply chain models
Once a company understands the factors driving its business, then it can determine which of six common supply chain models identified by the Supply Chain Roadmap best matches those criteria. These six are grouped in two categories: supply chain models that are oriented to efficiency, and those that are oriented to responsiveness. Figure 3 provides a detailed summary of the characteristics of these models, which are discussed below.

Supply chains oriented to efficiency
In industries where the value proposal is oriented toward low cost and/or high relevance of asset utilization to total cost, end-to-end efficiency is a must. Examples of such industries include cement, steel, paper, commodities, and low-cost fashion, among others. They are best suited to one of three supply chain types—"efficient," "fast," and "continuous-flow"—that are best able to maximize asset utilization:

The "efficient" supply chain model
The efficient supply chain is best suited to industries that are characterized by intense market competition, with several competitors fighting for the same group of customers who may not perceive major differences in their value proposals. In effect, competition is virtually always based almost solely on price.

Because customers in these commoditized businesses take an opportunistic approach to purchasing in order to ensure that they get the best price for each order, it results in a demand profile with recurrent peaks. Consequently, a continuous-replenishment model is inappropriate. Production should instead be scheduled based on sales expectations for the length of the production cycle, using a model based on a "make to forecast" decoupling point. Competitive positioning, therefore, depends on offering the best price and perfect order fulfillment.

Managers should focus on promoting maximum end-to-end efficiency. There are two main actions they can take to accomplish this. First, they should ensure high rates of asset utilization coupled with high overall equipment efficiency (OEE) in order to reduce cost. And second, they should ensure high levels of forecast accuracy to guarantee product availability and consequently, perfect order fulfillment.

For this supply chain model to be successful, the following factors should be in place:

There should be extra capacity in outbound logistics, to absorb demand peaks without affecting the ability to meet customers' expected receiving dates.

The SKU portfolio should be trimmed back to reduce the number of "high variation, low demand" SKUs, which create complexity in production and service.

The production cycle should be scheduled in a logical sequence of SKUs, with the aim of reducing setup time between each pair of adjacent SKUs. The production sequence should be fixed and maintained for long periods of time. This will help to increase the manufacturing line's experience with each setup, reducing the amount of time it takes for changeovers and, consequently, the length of the production cycle.

When transportation cost is highly relevant to the total cost, a minimum order-size policy of a full truckload is recommended. An alternative is a fixed order-cycle policy that allows the company to consolidate certain customers' orders on the same truck. For example, orders for customers in a particular region would be consolidated every Tuesday at 5 p.m. and dispatched the next day.

When market demand evidences seasonal trends, extra warehousing capacity should be available in anticipation of the need to store additional product during high-demand periods.

Customers whose buying behavior follows a regular, predictable pattern should be invited to participate in collaborative programs. These are programs where supplier and customer share supply and demand forecasts and schedules in order to reduce demand variability. The purpose is to migrate them to a continuous-replenishment model, and then step-by-step to convert the supply chain model from efficient to continuous-flow (discussed later), which is a more mature model that generates higher levels of customer loyalty.

This supply chain model is well suited for businesses with commoditized products, such as cement and steel.

The "fast" supply chain model
The fast supply chain is best for companies that produce trendy products with a short lifecycle. From the customer's perspective, the main difference among competitors' value proposals is how well they are able to update product portfolios in accordance with the latest trends. This focuses competition in the market on manufacturers' ability to continuously develop new products they can sell at an affordable price. As a result, the main driver of competitiveness is the reduction of market mediation costs. In an industry framework characterized by a short lifecycle, this might appear to be a conundrum, but with an understanding of market trends and consumers' habits, it is possible to maintain market mediation cost at an optimal level.

Production should be scheduled in a single batch per SKU, with its size defined by sales expectations for the sales season (or collection, in the fashion industry), using a model based on a "make to forecast" decoupling point. As the product line's sales season becomes shorter, it gets more difficult to produce a second batch of the bestselling products from the collection and replenish it to stores before the product goes out of fashion and consumers no longer want to buy it.

Management should focus on promoting continuous portfolio renewal, which is supported by three main capabilities: short time from idea to market, maximum levels of forecast accuracy in order to reduce market mediation cost, and end-to-end efficiency to ensure affordable costs for customers.

For this supply chain model to be successful, the following factors should be in place:

For companies with high levels of seasonal demand, there must be a pool of suppliers that can provide additional capacity as needed. Although outsourced manufacturing could be more expensive than in-house manufacturing, in the long term it would be less expensive than unused capacity.

"Classic" SKUs, defined as those that have a permanent presence in the product portfolio, should be replenished under a continuous-flow supply chain model.

The fast supply chain model is the most demanding in terms of forecast accuracy, because it has to constantly anticipate market trends. This creates the highest level of market mediation cost; consequently, state-of-the-art forecasting techniques and a synchronized sales and operations planning (S&OP) process are required.

Because product portfolios are extensive and change frequently, there will be many SKUs with low sales volumes. Therefore, it is very important to develop the ability to produce small lots and to purchase raw materials in small quantities.

Standardization of raw materials and limiting their variety reduces sourcing complexity. In addition, modular processes and sharing of raw materials among several SKUs helps to ensure fast product development and manufacturability.

When a company slows the rate of portfolio renewal or lengthens the lifespan of its product collections or marketing campaigns, it should migrate to an efficient supply chain. This will allow it to reduce batch sizes and to manufacture based on several batches of the same SKU during the term of the collection or sales season.

Examples of companies that benefit from this supply chain model include those that engage in catalogue sales. Companies in this industry segment typically launch new marketing campaigns every three or four weeks, and each catalogue may refresh more than 50 percent of the SKUs featured. It's also appropriate for retailers that sell trendy apparel and whose customers tend to visit stores monthly. These retailers need to update their stores' SKU portfolio every few weeks so loyal customers see a fresh image at each visit.

The "continuous-flow" supply chain model
The main features of the continuous-flow supply chain model are supply and demand stability, with processes scheduled in such a way as to ensure a steady cadence and continuous flow of information and products. This model typically is for a very mature supply chain with a customer demand profile that has little variation. Consequently, the production workload can match demand through a continuous-replenishment model based on a "make to stock" decoupling point, where production is scheduled to replenish predefined stock levels based on a specified reorder point for inventory in the production cycle. Accordingly, competitive positioning is based on offering a continuous-replenishment system to customers in order to assure high service levels and low inventory levels at customers' facilities, thus achieving optimization of costs associated with inventory.

Management should focus on promoting supply chain collaboration, which is supported by three main capabilities. In the early stages, they include electronic transactions that are used to reduce the number of transactional processes required during the order cycle, as well as the sharing of sales and inventory information to improve the ability to predict demand. In the most mature stage, collaborative planning with key customers helps to anticipate demand patterns.

For this supply chain model to be successful, the following factors should be in place:

Companies should use a prescheduled order cycle—for example, receiving orders from a group of customers the same day every week—instead of a lead-time order cycle, in which orders are dispatched based on a fixed lead time after order entry, independent of when an order is received. A lead-time order cycle could create demand peaks, and thus break up the continuous flow.

High-variance SKUs should be buffered with higher levels of inventory in order to avoid unexpected changes in the production schedule.

The production cycle should be scheduled in a logical sequence of SKUs, with the aim of reducing setup time between each pair of adjacent SKUs. The production sequence should be fixed and maintained for long periods of time; this will help to increase the manufacturing line's experience with each setup, reducing the amount of time it takes for changeovers and consequently, the length of the production cycle.

Collaborative efforts should be oriented toward customers that generate higher sales and those with high demand variability. For the latter group, if demand variability continues even after participation in a collaborative program, then it would be advisable to evaluate whether to shift them out of those programs. This is because they are forcing the supply chain to increase inventory or to break up a production sequence, both of which affect supply chain efficiency.

When demand variability moves in irregular patterns and/or customers are moving toward an opportunistic approach—that is, they are looking for the best price without regard for other benefits, such as lower working capital—it is wise to consider migration to an efficient supply chain.

This supply chain model typically works well for businesses with short-shelf-life products, such as dairy products and bread. It is also suitable for manufacturers of intermediate products, such as original equipment manufacturer (OEM) parts for assembly.

Supply chains oriented to responsiveness
Industries that face considerable demand uncertainty, where market mediation cost is highly relevant, should employ one of three different supply chain approaches that are oriented toward providing capacity in response to changes in demand. These include the "agile," "custom-configured," and "flexible" models.

The "agile" supply chain model
The agile type of supply chain is useful for companies that manufacture products under unique specifications for each customer. This is typically seen in industries that are characterized by unpredictable demand. They use a "make to order" decoupling point, producing the item after receiving the customer's purchase order to avoid manufacturing products that have no certainty of future sales.

As a result, the main driver of competitiveness is agility—the ability to meet unpredictable demand, in quantities exceeding the customer's forecast and/or within a shorter lead time than agreed. The ability to be agile is proportional to the ratio between excess capacity and the average rate of asset usage. In strict terms, there can be no agility without excess capacity.

Management should focus on ensuring agility, which is supported by two main capabilities: excess capacity, and products and processes designed to produce the smallest possible batches.

For this supply chain model to be successful, the following factors should be in place:

In order to reduce lead time, materials and components should be designed for a common platform (a group of products that share some key components) and they should always be available in inventory.

Low-variance customers should be protected by lower prices to prevent their defection to efficient competitors. Furthermore, customers with high demand variation should pay higher prices.

Collaborative relationships with key customers are important. They will help suppliers anticipate changes in capacity requirements, both in the short term for scheduling purposes and in the long term for asset-investment decisions.

If extra capacity gradually decreases to low levels, the company should invest in additional assets so it can maintain its ability to be agile. If it cannot do so, then it should migrate to an efficient or a continuous-flow supply chain and adjust its value proposal from agility to efficiency.

Generally, this type of supply chain is employed by manufacturers of intermediary goods that make products for industrial customers according to each customer's specific needs, and by companies whose industrial customers place a high value on short lead times. This strategy is useful for industries where the company's value proposal is oriented toward offering products "on demand" and with a high service level, such as packaging, chemical specialties, and metal machining services, among others.

The "custom-configured" supply chain model
The custom-configured supply chain model is characterized by a high degree of relevance of the cost of assets to the total cost, and multiple (potentially unlimited) configurations of the finished product on a unique platform. Competitive positioning is founded on offering a unique configuration of the finished product according to the end consumer's needs. Unlike in an agile supply chain, where the product can be customized to meet virtually any customer requirement—limited only by technical constraints—in this supply chain, the product is configurable within a limited combination of product specifications, usually by combining parts into a set or assembly.

Usually, product configuration is accomplished during an assembly process, where some of the parts are mounted or assembled according to an individual customer's requirements. However, product configuration may be done in other types of processes, such as mixing, packaging, and printing, among others. As a general rule, the processes before product configuration are lengthier than the configuration itself and the downstream processes.

Because of the nearly unlimited number of possible finished products resulting from multiple combinations of parts or materials, it is practically impossible to make an accurate forecast. Other complicating factors include the finite number of materials or pieces, and the fact that processes that occur prior to configuration are scheduled according to a forecast or a continuous-replenishment model, depending on the variability of the demand profile. Consequently, product configuration and downstream processes are scheduled after receiving the customer's order, and to ensure a short order cycle those processes are designed with extra capacity available.

Because of those factors, this type of supply chain employs a "configurable to order" decoupling point, where the processes occurring before configuration are managed under an efficient or a continuous-flow supply chain model, and the configuration and downstream processes operate as in an agile supply chain.

For this supply chain model to be successful, the following factors should be in place:

The order-entry system should be detailed and accurate as well as user-friendly to ensure, respectively, a clear understanding of customers' requirements, and that it will be easy to use from the customer's perspective.

Processes before configuration should be managed under the criteria of an efficient or a continuous-flow supply chain, in accordance with the characteristics of the demand profile.

Configuration and downstream processes should be managed under the criteria of an agile supply chain.

Manufacturers should maximize the number of possible configurations for a product platform while minimizing the materials and/or parts used for that platform. This is the key factor in reducing complexity in this type of supply chain.

To prevent the order cycle from becoming longer, it is necessary to ensure the availability of materials and/or parts prior to the configuration process.

The most popular product configurations should be available in finished-goods inventory, managed under an efficient or a continuous-flow supply chain model.

One example of where this supply chain strategy makes sense is the assembly of personalized products, such as computers and vehicles. Another example is in the paper manufacturing industry, where the decoupling point occurs after the manufacture of the big paper rolls, and the products are customized in the cutting and packaging process. In the service sector, some fast food restaurants apply this supply chain model.

The "flexible" supply chain
The sixth supply chain type, the flexible model, is suited for companies that must meet unexpected demand and therefore are faced with high demand peaks and long periods of low workload. This supply chain model is characterized by adaptability, which is the capability to reconfigure internal processes in order to meet a customer's specific need or solve a customer's problem. This model typically is used by service companies that focus on handling unexpected situations, perhaps even including emergencies. Due to the nature of such events, customers appreciate not only the speed of a supplier's response, but also its ability to tailor solutions to their needs. Consequently, the price becomes largely irrelevant to the customer.

Management should focus on ensuring flexibility, which is supported by four main capabilities: extra capacity of critical resources, rapid-response capability, technical strengths in process and product engineering, and a process flow that is designed to be quickly reconfigurable.

For this supply chain model to be successful, the following factors should be in place:

Companies should keep critical resources (for example, pumps for companies that provide flood recovery services, or metal machining equipment for spare-parts manufacturing) available on stand-by. This may require pooling of critical resources—including with those of competitors—because these companies address unexpected situations that could easily result in demand exceeding capacity, and it is not economically feasible to have unlimited capacity.

Strong collaborative relationships with key suppliers are necessary for companies to understand at every moment their current "available to promise" inventory and capacity.

Adaptability is based on having many resources of low to medium capacity, instead of a few resources of high capacity.

A well-designed order-entry process is critical, in order to ensure a proper understanding of the customer's situation and requirements.

A typical example of this type of supply chain can be found in companies that provide metalworking and machining services for the manufacture of spare parts for industrial customers. This type of company may encounter emergency situations such as the need to immediately replace broken parts. Accordingly, they must be able to provide a fast response and sufficient capacity to develop unique parts by combining successive processes, such as turning, reaming, and welding, in a configuration adapted to a specific situation.

Simultaneous capabilities, or multiple supply chains?
Organizations tend to want their supply chains to have simultaneous capabilities: efficient, fast, agile, custom-configured, and flexible, among others. Yet each of these capabilities requires different skills, and in the majority of cases, these skill sets are incompatible within the same supply chain. However, it is possible to develop several parallel supply chains within a single organization, each focused on a defined market segment with a responsiveness level and a cost structure that are appropriate to the segment it serves.

The most powerful benefits of the "Supply Chain Roadmap" arise from its ability to help demystify the process of formulating supply chain strategy. As suggested by the overview in Figure 4, it does so by identifying the key drivers of business strategy, and then helping managers understand how those drivers would align in a coherent way with each of the six generic supply chains. This makes it possible to select the supply chain type that best fits a particular business segment.

Hernán David Perez, the developer of the Supply Chain Roadmap method, is supply chain manager of a home-improvement retailer and teaches supply chain management at Universidad de la Sabana in Bogotá, Colombia.

hdperez at supplychainroadmap.com

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